Four Corners of Energy

From an electric and gas point of view, it looks like investors could be in for a bumpy ride. As policymakers rethink deregulated markets, one of the safer places has become pipes and wires. Today, the king of pipes and wires is Dominion Resources (D).

It is about government regulation. In the U.S., every wire and every pipe is regulated. It is true that many utilities were deregulated. However, in every case, deregulation was limited; it did not touch utility wires or pipes.

After being burned in the reregulated markets, most utilities are finding they prefer having the government regulate their assets. Their downside is minimized and their revenues are hedged. Regulated assets are not subject to the market and utility managements are assured of returns.

There are two types of wires and pipes. One is federal. The other is state. Any pipe or wire crossing state lines is regulated by the federal government. All wires and pipes staying within state lines are regulated by individual states.

Most of the nation's small wires and pipes are called local distribution systems. To the extent those systems remain within state lines, they are regulated by the state utility commission. Most small-bore assets are owned by local distribution companies like Consolidated Edison (ED), Northeast Utilities (NU), Pepco Holdings (POM) and WGL Holdings (WGL).

While regulated assets are preferred, as Duke Energy (DUK) and Pepco learned, profits are not assured. If regulators become upset, utilities lose revenues. Before investing in local distribution companies, be sure to check each state to see if its utilities are earning fair returns.

The environment is different with the big pipes and big wires. These systems form the backbone of the nation's infrastructure. Their objective is to deliver and drop off commodity to local distribution systems. Most are regulated by the Federal Energy Regulatory Commission.

Investors should be aware that FERC's regulatory policies are designed to promote investment. FERC-regulated utilities usually earn a fair return on their assets. However, the returns are for the company's top line, not their bottom line. Consequently, a utility's ability to produce returns is determined by management.

On the electric side, the nation's only pure play on FERC-regulated transmission lines is ITC Holdings (ITC). Companies like American Electric Power (AEP) and Integrys Energy (TEG) are not pure plays, but they own significant FERC-regulated transmission lines.

Interstate natural gas pipelines are also regulated by the FERC. According to the Energy Information Administration (EIA), two-thirds of the lower 48 States are dependent upon the interstate pipeline system for their supplies of natural gas.

As the map illustrates, some of the largest levels of pipeline capacity exist on those natural gas pipeline systems that link the natural gas production areas of the U.S. Southwest with the other regions of the country. Sixteen of the thirty largest U.S. natural gas pipeline systems originate in the Southwest Region, with four additional ones depending heavily upon supplies from the region.

Natural Gas Map Courtesy of EIA

Today, almost every major metropolitan area in the U.S. is supplied by, or is the final destination of, one or more of the major interstate pipeline companies or their affiliates.

For instance, New York City is a major delivery point on several of the largest pipeline systems, including Spectra Energy's (SE) Texas Eastern Transmission Company, Williams Partners' (WPZ) Transcontinental Gas Pipe Line Company, Kinder Morgan Energy Partners' (KMP) Tennessee Gas Pipeline, and Iroquois Gas Transmission Company. Iroquois is jointly owned by TransCanada (TRP) at 44.48%, Dominion at 24.72%, National Grid (NGG) at 20.40%, New Jersey Resources (NJR) at 5.53% and Iberdrola owns the balance.

Combining the four quadrants of federal and state electric and gas systems, one of the more interesting companies is Dominion Resources. Most of its assets are spread across all four quadrants. On the federal side, Dominion's portfolio includes 6,000 miles of transmission lines and 11,000 miles of natural gas pipelines. On the states' side, Dominion owns almost 60,000 miles of electric distribution lines and 22,000 miles of gas distribution pipelines. They own a fleet of regulated or contracted generating assets. In addition, Dominion has been retreating from most of the deregulated markets.

Dominion is an expensive stock. At 57, its price-to-earnings ratio is through the roof. However, its bottom line earnings are likely to improve as it absorbs write-downs associated with its winding down of deregulated activities.